PBOC's `Vicious Cycle' Worsened by Fed, Yu Yongding Says
Moves by the U.S. Federal Reserve to print cash would spur capital flows into China, hampering the Asian nation’s efforts to damp inflation and counter yuan gains, said Yu Yongding, a former central bank adviser.
The People’s Bank of China sold a net 209.7 billion yuan ($32 billion) of bills during the last nine months, following net redemptions of 579.5 billion yuan in 2009. It raised the reserve-requirement ratio last week for six banks, including the largest four, by half a percentage point for the fourth time this year, a move China Securities Co. estimated will cut lending by 170 billion yuan.
Cash is pouring into China to profit from economic growth that’s averaged more than 10 percent for the past five years and accelerating yuan gains following the end in June of a two-year peg. The nation’s foreign-exchange reserves jumped by $100 billion in September to a record $2.65 trillion, the biggest increase since Bloomberg began tracking the data in 1995, and the inflation rate hit a 22-month high of 3.5 percent in August.
Increases in reserve ratios or interest rates “only encourage fresh inflows on the anticipation that further hikes or yuan appreciation are in the pipeline,” Yu, who is based in Beijing, wrote in an e-mailed response to questions on Oct. 15. “This vicious cycle is self-defeating.”
China raised its benchmark lending and deposit rates for the first time since 2007 after the markets closed today. The one-year deposit rate will increase to 2.5 percent from 2.25 percent, effective tomorrow, the People’s Bank of China said on its website. The lending rate will increase to 5.56 percent from 5.31 percent, it said.
Yuan forwards were little changed with the 12-month non- deliverable contract trading at 6.4425 at 7:48 p.m. in Hong Kong, compared with 6.4358 before the announcement. That indicates traders are betting on a 3.2 percent appreciation.
The yuan has strengthened in each of the past six weeks, the longest winning streak since July 2008, and touched 6.6404 per dollar on Oct. 15, the highest level since the central bank unified official and market exchange rates at the end of 1993.
The Fed may add to its existing $1.7 trillion of asset purchases to help stimulate the U.S. economy, according to minutes of a Sept. 21 policy meeting. Goldman Sachs Group Inc. estimated the central bank will announce about $500 billion of Treasury purchases through mid-2011, helping keep U.S. interest rates low and spurring demand for higher-yielding assets.
“A consequence of quantitative easing is more capital flows into emerging markets, and China seems an easy target, for both higher returns to investment and expectations of yuan appreciation,” Tao Wang, a Beijing-based economist at UBS AG, wrote in an Oct. 14 research note.
After the central bank issues yuan to limit currency gains, it needs to tighten monetary policy to contain inflation, regardless of whether yuan appreciation picks up, she said.
The People’s Bank cut interest rates in 2008 and suspended sales of 12-month and three-year bills to bolster liquidity and spur lending as a global recession took hold. It resumed sales of 12-month notes in July 2009 after economic growth reached a three-year high of 11.9 percent during the first quarter.
The central bank sold 43 billion yuan of 12-month debt today. It’s kept the yield at 2.0929 percent for the past 18 weekly sales, the highest level since November 2008.
The rate on similar-maturity U.S. Treasuries, the favored investment for China’s foreign-exchange reserves, fell 22 basis points this year to 0.21 percent for similar-maturity notes, worsening the central bank’s losses from intervention.
“Unless capital controls are effective, higher costs of sterilization and the various inefficiencies this leads to, will once again highlight the problems of not allowing the currency to do its job,” said Yu, currently a member of the state-backed Chinese Academy of Social Sciences.
Government data due Oct. 21 will show China’s economic growth slowed to 9.5 percent in the third quarter, from 10.3 percent in the previous three months, and consumer prices increased 3.6 percent in September, based on the median estimates of economists surveyed by Bloomberg News.
China’s benchmark 10-year bonds yielded 3.41 percent today, rising from as low as 3.26 percent on July 14. That compares with 2.52 percent for similar-maturity Treasuries. Five-year interest-rate swaps, the fixed rate needed to receive the floating seven-day repurchase rate, have risen 17 basis points this month to 3.12 percent, according to data compiled by Bloomberg. A basis point is 0.01 percentage point.
Central Bank Governor Zhou Xiaochuan said Oct. 9 that current “quantitative tools” are sufficient in containing inflation expectations.
The central bank’s one-year deposit rate compares with benchmark interest rates of a maximum 0.25 percent in the U.S. and Japan. China’s three-month Shibor, which measures interbank lending costs, has risen 82 basis points this year to 2.65 percent. The equivalent Libor rate for dollar loans is 0.29 percent.
Capital flooding into Asia could lead to excessive exchange-rate moves, asset bubbles and financial instability, Dominique Strauss-Kahn, the head of the International Monetary Fund, said in Shanghai yesterday. Some flows “can clearly be destabilizing,” he said.
Pressure on the yuan to gain may increase after the interest-rate increase, Dariusz Kowalczyk, a Hong Kong- based senior economist and strategist for Credit Agricole CIB, said in an interview.
“The market was unprepared,” he said. “Probably there will be more portfolio inflows into China and the currency will gain in the non-deliverable forward market. They have must have decided to be tougher on inflation and stimulate savings, because otherwise there will be asset bubbles.”
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